The Russian Market Is Ready For Immersion

Summary

The external conditions, favorable for the functioning of the Russian stock market, are unlikely to continue.

The reduced rate of GDP decline in Russia cannot be considered stable.

A correction of the MSCI Russia index is possible in the coming months.

Reaching a historical high in late April, the Russian stock market remains at a relatively high level, demonstrating the lateral movement of quotations. Clearly, the market is consolidating before the next directional movement. The question is: in what direction?

The ambient background clearly favored Russia during the last quarter. The oil price reached almost $50 per barrel, while the budget of the Russian Federation for 2016 implies the price of $40 per barrel. As a consequence, the ruble strengthened. FRS's prudent pace of the U.S. monetary policy tightening had, in general, a calming effect on the world markets and put pressure on the dollar.

The key macroeconomic indicator of Russia also improved. So, according to the preliminary data, the GDP drop in Q1 2016 amounted to 1.2% YOY vs. 2.8% YOY a year earlier. It is worth noting that this result exceeded the average expectations of many analysts. For example, Bloomberg was expecting to see a drop of 2% YOY.

To date, the Statistical Service of Russia does not provide information on changes in the GDP structure. But, given that Russia's foreign trade turnover in Q1 2016 decreased by 26.4% YOY, reaching $97.7 billion, the slowdown in GDP reduction was obviously due to the improved household consumption. But, in my opinion, this is a temporary situation and it is associated primarily with the strengthening of the ruble.

My pessimism is based on the following factors.

Primarily, unemployment in Russia continues to grow. In March, the figure reached 6%, after it remained at 5.8% during 4 months. The hidden unemployment continues to grow. The amount of wage arrears grew by 51.7% YOY in April, and the real paid wages decreased by 3% YOY in March.

I also draw pessimistic conclusions from the recent data on the change in business activity in Russia.

According to Markit, the industrial PMI index in April dropped to an eight-month minimum. The manufacturers indicated a reduction in new and pending orders. Moreover, the reduction of pending orders is continuing for twenty-four consecutive months. Thus, the fall in the number of orders allows manufacturers to quickly complete the earlier received orders and to decrease the production capacity, which leads to reduction of working places. This logical chain is directly confirmed by the Markit research.

Click to enlarge

On the opposite, the PMI index of the service industry has demonstrated the maximum growth of business activity from March 2013. But, despite the increase in new orders, the companies engaged in the service industry continued to cut jobs in April. Moreover, according to the Markit report:

"...The rate of job shedding accelerated from March and was strong in the context of long-run historical data..."

Click to enlarge

So, what kind of the future stable growth of household consumption are we talking about if the industrial enterprises and the service industry continue to reduce jobs? Maybe I'm overly pessimistic and will be extremely happy to receive constructive criticism.

I have already predicted the weakening of the ruble and I can see the first market indications that my prediction is starting to come true.

I also see no reason for the oil price to grow above the level of $50. Most probably, OPEC will maintain their current policy aimed at protecting their market share, while Russia will answer with a symmetric production growth. Also, the current price level allows the shale producers to hedge their oil transactions for 2017, which will slow down the fall in oil production in the United States. In short, it is unlikely that the Russian market will also be supported by the relatively expensive oil in Q2.

And, finally, after the publication of the protocol of the April FRS meeting and the positive U.S. macro statistics for April, I have almost no doubt that the U.S. monetary policy tightening will follow in June. Last time, it reduced the MSCI Russia index by nearly 10%. And I don't see any reason why the Russian stock market will now react differently to this event. However, given the current price levels of the stock market of the Russian Federation, this time the correction may be much deeper.

Click to enlarge

Unless otherwise noted, all charts included are my own.

Disclosure:I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.